President Donald Trump often talks about terrible trade deals but he misses an important piece of information-- America benefits from the expansion of global free trade. The real worst trade deal would be a return to the pre-World War Two era of isolationism.
In February, President Donald Trump spoke at the Boeing assembly plant in South Carolina. Standing in front of a Boeing aircraft he said, “our goal as a nation must be to rely less on imports and more on products made here in the US”. As Kevin Williamson of the National Review put it at the time, “this is, to use the technical term, stupid”.
We Are What We Produce
The great irony of Donald Trump’s speech is that American manufacturing output is at historic highs. A lesser irony was this: plane Trump is standing in front of is assembled in the United States but its construction completely reliant on foreign trade.
This is not just an anomaly for Boeing but a standard story throughout the whole US economy. Over half of American imports are used in American production. This is not a glitch but a huge benefit.
This brings up an important point-- what we manufacture. In America, we produce, manufacture and assemble gas turbines, circuits, packaged medical equipment, medical instruments, and oil. These take an education and result in good paying jobs.
In China, over twenty percent of what they assemble is telephones, broadcasting equipment, and computers. Now notice I said assembled.
Most high-tech parts are made outside of China, in America, Europe, Japan, and South Korea. Trade allows the US to assemble high-value goods, while China assembles low-value goods. Fifty-three percent of America’s gross output is value added, while it is only thirty-five percent in China.
The Economics of Trade
This is a perfect example President Trump’s tendency for government intervention into the free market. But his protectionist tendency is worse than his general interventionist tendency. Economic intervention, although I disagree with it, can be justified. Protectionism has been cast into the dustbin of bad ideas by economists for decades.
Let me start with critical a mistake the Trump team makes in this discussion of trade. The Trump team is under the assumption that trade deficits shrink Gross Domestic Product or GDP (calculated by adding consumption, investment, government spending and net exports). The basic argument goes like this: because GDP is calculated by adding net exports, that means that imports subtract from GDP, meaning they make the economy smaller.
While they are technically right about imports technically subtracting from GDP they ignore why. GDP is Gross Domestic Product and as its name implies it is about domestic production. Imports are counted when you purchase them in consumption but since they aren’t produced domestically they need to be subtracted via net exports meaning that the effect is neutral.
But what if we produced X in America instead of in another country? Then we would be able to add Y billion to the economy so we lose potential gains? The simple answer is comparative advantages. Goods are being produced in other countries because they have a comparative advantage.
This means that they are cheaper at it than we are, meaning that we can buy the same amount of goods for less so we can either buy more of that good or buy something else that we wouldn’t be able to afford otherwise.
The Trade Deficit Myth
Think of it this way. You have a trade deficit with your local grocery store but no
one would think this is bad. Your grocery store has a comparative advantage compared to you when it comes to food. Sure, you could growth your own food but it would cost far too much time, money.
The same idea applies to international trade. The goods other countries produce lets us focus on goods we are better at allowing us to have more than we could otherwise.
But still, are deficits not bad? Are we not giving more to other countries than we get back? The problem with trade deficits is that they ignore the movement of money used in investment. When we send a dollar overseas to buy goods, the country we sent it to cannot use it.
Only America uses dollars. Because of this, they must send it back in the form of capital investment. That is why the opposite of the trade deficit is the capital surplus.
Donald Trump’s views on trade are not just contrary to basic economics but also to the economic consensus and empirical evidence. The Chicago University IMG forum of leading economists found overwhelming results.
Not one economist disagreed with the statement that “freer trade improves productive efficiency and offers consumers better choices, and in the long run these gains are much larger than any effects on employment.”
For a full assortment of studies demolishing the protectionist case see here and here but I will highlight a few now:
A World Bank study found that “…there are only two major cross-country empirical studies that look at the impact of trade policy on unemployment rates. One is [a] paper by Dutt, Mitra, and Ranjan (2009) and the other is [a paper] by Felbermayr, Prat and Schmerer (2011). Both papers show that countries that have less protectionist (more open) trade policies have lower unemployment rates.”
A 2013 meta-analysis from the Czech national bank reviewing 60 studies found, “strong positive effects [of liberalization] on long-run growth” even after correcting for bias and misrepresenting evidence.
Free trade supports over five million American jobs. Similarly, the poorest ten percent of Americans, gain sixty-two of their purchasing power from free trade, while the median American gains twenty-nine percent. Protectionism is a regressive tax on the poorest Americans.
It raises prices for them so those political connections can get special favors from politicians to not have to compete with foreign products they couldn’t compete with otherwise.
The Boogeyman Of Trade
We cannot have a discussion on trade and Trump without touching NAFTA. For those who do not know, NAFTA is the North American Free Trade Association and it helped expand the free flow of goods between America, Canada and Mexico.
In an August rally, President Trump said about NAFTA, “we have been so badly taken advantage of…we'll end up probably terminating NAFTA at some point…”.
The same poll of economists was asked if “on average, citizens of the U.S. have been better off with the North American Free Trade Agreement than they would have been if the trade rules for the U.S., Canada, and Mexico prior to NAFTA had remained in place.” Again, not one economist disagreed.
NAFTA has an impressive record of improving economic welfare, decreasing American pollution, and increasing cross border investment.
To paraphrase the great economist, and Nobel Laureate Milton Friedman, free trade is in the general interest of every American. Yes, some people are hurt by trade but every policy has winners and losers. A car factory worker in Michigan is hurt just as much when his jobs leaves for Alabama as when it leaves for Mexico.
Economic advancement has always caused pain but temporary unemployment is a necessary ill for economic success. Instead of protecting dying jobs, we should focus on helping others get better jobs and finding opportunity.